Positive analysis: description and prediction of human behavior (using models)
Model : – a simplified theory applied to a specific situation, from which a prediction can be derived
– contains variables and parameters.
Normative analysis: evaluation of the outcome(s) of positive analysis with regard to any given criterion (in Economics, this would be welfare or efficiency) .
Example of a positive theory : market equilibrium.
Example of a positive model : with negative externalities, the amount traded (in equilibrium) is greater than the efficient amount.
Example of normative analysis : levying a Pigovian tax in order to internalize a negative externality results in efficient behavior.
In Economics, normative analysis always is based on a positive core.
20050803.doc - 1 Dr. Roland Kirstein, Visiting Professor UCSB
Law and Economics 117A, Summer Session B

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Only 17 out of 72 (23.6%) gave 6 or more correct answers!
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20050803.doc - 2 Dr. Roland Kirstein, Visiting Professor UCSB
Law and Economics 117A, Summer Session B

#1 Derivation of the results: a) W=300-2p <=> 2p=300-W <=> p(W)=150-0.5W b) p(W)=MC <=> 150-0.5W = 0.5W <=> W=150 into p(W)
Note that because the demand curve represents the marginal utility of W, the area under the demand curve represents the total utility of a certain amount of W.
The competitive equilibrium (p*, W*) allows for two interpretations:
• positive - this is the outcome predicted for profit-/utility-maximizing actors;
• normative - this quantity maximizes net social welfare. c) R=p(W)W=150W-0.5W
2 => MR=150-W; MR=MC => W M =100 into p(W)
The monopoly solution leads to a welfare loss (triangle). d) SMC = 50+0.5W => p(W)=SMC(W) => W’=100 into p(W)
The negative externality will be internalized if a Pigovian tax is levied. Another way to achieve efficiency would be to allow for a monopoly in the market. This is typical for second-best problems: adding a deviation from perfect competition (such as a tax or monopoly) to another one (an externality) does not necessarily decrease welfare, but may even increase it.
20050803.doc - 3 Dr. Roland Kirstein, Visiting Professor UCSB
Law and Economics 117A, Summer Session B

20050803.doc - 4 Dr. Roland Kirstein, Visiting Professor UCSB
Law and Economics 117A, Summer Session B

#2: Game theory = interactive decision making
Normal form game (N,S,U)
• Set of players N={1; 2}
• Each player’s strategy set S i
= {C; D}, i ∈ N
• Each player’s payoff function U x S
2 i
: S
1
→ IR
WHO may DO WHAT, and with WHAT consequences?
A Nash-Equilibrium is a pair of strategies with the following property: No player wants to reconsider his choice, given that the other player chooses her equilibrium strategy. a) Prisoners’ Dilemma b) coordination game c) pure conflict
1,2 C
C 3,3
D
1,4
1,2
C
C D
4,4 1,3
1,2
C
C
4,3
D
1,4
D 4,1 2,2 D
Nash-Equilibria in pure stratgies:
3,1 2,2 D 3,2
D,D D,D and C,C none
2,1
20050803.doc - 5 Dr. Roland Kirstein, Visiting Professor UCSB
Law and Economics 117A, Summer Session B